TLDR:

• The growth of DeFi has been possible because of the major improvements in DEX liquidity in 2020
• DEXs today support small trades well, but struggle to provide competitive pricing for medium & large trades
• 0x’s new Request for Quote (RFQ) system allows professional market makers to bring CEX liquidity directly to DEX users to support great pricing for medium and large trades
• Get started today with our documentation

DEX growth and the rise of aggregators

It’s an exciting time in crypto. There are $6 billion locked in DeFi protocols, and DeFi’s roaring growth has pushed DEX trading well over $2 billion a week! To give you some perspective, that is 5000% growth when compared to 2019’s total volume traded of around $2.3 billion for the entire year.

The incredible growth of DeFi wouldn’t have been possible without some of the key upgrades to DEXs over the past 8 months. The biggest trends have been a deepening of DEX liquidity in AMMs across a wide set of commonly traded pairs as well as a move towards DEX liquidity aggregation.

Automated market makers have made large strides in 2020. Curve has unlocked powerful stablecoin trading, Balancer has allowed new pricing strategies to be tested, and Uniswap’s V2 has become a go-to destination for new token teams looking to bootstrap liquidity. The innovation across these protocols has attracted new capital spread across all 3. This has been great for users because deeper liquidity means better pricing, but as liquidity has been spread across a larger set of protocols, users and applications have had a harder time locating the best price. The good news is that DEX liquidity aggregation has popped up to solve this exact problem. DEX liquidity aggregation is the ability to combine liquidity from multiple protocols in order to fulfill a single trade. Historically, DEX traders could only interact with one liquidity protocol at a time. Today, DEX aggregators can look at every DEX order book and liquidity pool at the same time and then slice and dice together the best possible order for their user. This saves traders time & money, enables larger trades to be much better priced than before, and because the best-priced liquidity is used in each trade, encourages healthy price competition between liquidity providers.

Where does DEX liquidity fall short?

‍The deepening of liquidity & move towards DEX aggregation in 2020 has allowed DEXs to support well-priced small trades across a wide set of pairs. The issue today is that DEXs have trouble supporting competitively-priced medium & large trade sizes, and that inability forces traders to either not trade large amounts at all or have to visit centralized exchanges. DEX trading needs to be able to consistently support well-priced medium & large trade sizes in order to support DeFi’s continued growth. That may sound easy, but supporting large trades is particularly difficult because liquidity providers must be willing to risk large amounts of money at one time.

How can DEXs support larger trade sizes?

‍In order for DEX to be able to support well-priced large trades, there are 3 main approaches:

1. Build more capital efficient AMMs that can handle large trades & be profitable through market fluctuations
2. Upgrade DEX order book technology to lower risks for market makers in highly volatile markets
3. Innovate to enable a new market-making behavior that lowers risk for market makers in volatile markets

While option 1 & 2 sound great, they are both improbable in the short term.

Option 1. AMMs are fantastic, but their greatest strength is also one of their biggest limitations; anyone can trade with them at any time. They are always in the market on both sides of the book and therefore AMM designs like Uniswap have chosen to be very conservative with their liquidity strategies. Conservative liquidity strategies are not capital efficient as they can only use a small portion of their capital to provide liquidity close to the market price. When AMMs choose to use a higher portion of their capital to provide liquidity close to the market price, they become much riskier for liquidity providers and can lose large amounts of money if the market price moves significantly in either direction.

Option 2. Lowering risks for market makers on Ethereum 1.0 order books is difficult. Market makers normally manage their risk through speed & effective hedging. On centralized exchanges, they can cancel an order and update their price almost instantaneously. They also have complete certainty about their order status and their account balance at any specific time. That is all possible because centralized exchange order books run on high-throughput back-ends that match orders between traders and market makers at lightning speeds. In comparison, DEX order books have to run on Ethereum 1.0 which is a low-throughput decentralized back-end. DEXs have therefore historically had high risks for market makers to support large trade sizes because of slow settlement speeds as well as expensive, non-guaranteed order cancellation. A market maker’s order needs to exist long enough for traders and applications to find and fill it, but if a market maker’s order becomes mispriced during that time due to the market price of the asset changing, an arbitrage bot will swoop in to fill the order before it can be canceled. One solution to this problem is to create a walled garden where the DEX becomes the middleman in the transaction and guarantees settlement, but this breaks composability as nobody outside of the walled garden can use this liquidity. In the short term, there doesn’t seem to be an elegant solution for DEX order books to be able to support well-priced medium and large trade sizes as the risks for market makers are still too high.

So, what about option 3? 0x originally worked with market makers to understand how to upgrade our order book model in order to better allow deeper liquidity for key markets. From our research, we learned that what market makers wanted depends on the market they were providing liquidity for. In volatile markets, providing deep liquidity at competitive prices wasn’t appealing to market makers through an order book on Ethereum 1.0 because of risks. We learned if we could change the risk for market makers, we could enable competitively priced large orders, and the way to do that was to change the entire liquidity provisioning process. In a highly liquid market like ETH/DAI, why post an order on an order book where it can be taken by an arbitrage bot when you can instead wait for a user’s request and then customize your response?

0x’s new Request For Quote model: OTC for DEX

0x has rebuilt almost its entire infrastructure in the past 9 months in order to better serve developers, traders, and market makers. We reworked the 0x smart contracts to make DEX liquidity aggregation a key part of their infrastructure. The new contracts allowed us to build out Swap API which is a simple way for anyone to access aggregated liquidity from 0x, Uniswap, Kyber, Balancer, Curve, and more.

Swap API gave us the perfect platform to change how market makers could provision liquidity. Historically, users of the API have sent in a request for liquidity and received back a response with an optimally routed order from multiple sources of on-chain & off-chain AMMs and order books. Building on top of this simple API experience, we created 0x’s new Request for Quote system which is simply an easy way for professional market makers’ to respond to Swap API requests. The user’s experience doesn’t change at all when using the API with the new Request for Quote liquidity turned on. The user still simply sends in a request for liquidity and receives back a response with an optimally routed order. The magic happens behind the scenes where a large group of professional market makers are able to respond to the user’s request and compete against on-chain liquidity to offer the user the best possible price. Here’s a quick diagram with the exact breakdown.

• Step 1: The user requests liquidity from the Swap API
• Step 2: The Swap API requests pricing information from all sources of on-chain liquidity as well as from a large set of professional market makers.
• Step 3 & 4: The on-chain liquidity & market maker responses are passed along to the Swap API which uses smart order routing to slice and dice together the best-priced fill for the user taking into account gas cost.
• Step 5: The Swap API passes back the best-priced order combination to the user who then signs and submits the transaction to the Ethereum blockchain.

What does this RFQ system mean for market makers?

‍The RFQ system is built to make it easy, profitable, and low-risk to provide large amounts of liquidity to DEX traders. Market makers using the system can choose when and with whom they would like to trade. Market makers naturally want to maximize their ratio of retail order flow to arbitrageur flow, and this system allows them to do that. How? RFQ liquidity is only available to known applications using the Swap API. That ensures that the applications using the system are respecting the system. In addition, applications requesting RFQ liquidity provide the address of the smart contract or user who will be consuming the liquidity. This allows the market maker to customize pricing per user and build an order that can only be filled by the user it is intended for. Market makers in our beta have been happily sharing that these two innovations have made their trades more profitable than trades on other DEXs.

In addition to all of the above, the 0x team is committed to helping market makers understand and diagnose how their liquidity is being used. We’re currently building tooling that allows RFQ market makers to compare their pricing against on-chain sources of liquidity in order to understand how they can best position their orders to provide good pricing to users, win trade flow, & be profitable long term.

What does this RFQ system mean for Swap API integrators?

‍Better pricing, especially for medium & large size trades. For every request that you send to the Swap API, the system will now parse through all on-chain liquidity sources as well as multiple custom priced orders provided to you by RFQ market makers. Our internal data has already shown us that RFQ market makers are able to price better than AMMs a high percentage of the time because of the protections that the system offers them. In major pairs like ETH/USDC, 0x RFQ market makers already fill up to 50% of the trade volume requested through the Swap API.

‍What does this RFQ system mean for the future of DEX?‍

DEX needs to be able to consistently support well-priced medium & large trades with composability in order to support DeFi’s continued growth. That is not only possible but is already happening today through 0x’s RFQ system. Through RFQ, professional market makers who are used to trading crypto on centralized exchanges and across OTC desks can easily enter the DEX market and trade large amounts with low risk. Those market makers can bring all of the liquidity that is available on centralized exchanges and offer it to DEX markets. The best part is that this new liquidity is incredibly easy to use for DEX wallets and DEX applications directly in Please reach out directly if you are interested in providing or consuming this liquidity. We’re happy to provide technical assistance to get you up and running.